Interest paid in line with US policy rate target range?currently 3.5?3.75%
Banks gain profitability advantage over overseas foreign currency investment
This enables attraction of foreign currency deposits under better terms?incentives for companies and individuals to park funds domestically increase
National Pension Service may conduct large-scale swaps next year?serves as groundwork for preparation
"Significant measure to address severe supply-demand imbalance?policy synergy expected"
The Bank of Korea will, for the first time ever, temporarily pay interest on excess foreign currency reserve deposits held by financial institutions. The aim is to stabilize the foreign exchange market and improve supply and demand conditions.
The Bank of Korea plans to pay interest at a level equivalent to the US policy rate target range (currently 3.5-3.75%), making it more profitable for financial institutions to keep their foreign currency funds domestically rather than investing them overseas. By encouraging financial institutions to attract foreign currency deposits under more favorable conditions, it is expected that companies and individuals will also have greater incentives to keep their foreign currency funds within the country. This measure is also intended to prepare for the possibility of the National Pension Service, which has declared a policy of "flexible FX hedging," engaging in large-scale FX swaps, thereby improving supply and demand. In line with this, the government has also decided to temporarily exempt the foreign exchange soundness levy.
Interest of 3.5-3.75% to be paid on excess foreign currency reserves-expected effects
On the 19th, the Bank of Korea held an extraordinary Monetary Policy Committee meeting and decided to temporarily pay interest on foreign currency reserves deposited by financial institutions. The interest will be paid monthly for the period from December this year to May next year, covering the period from January to June next year. After the reserve for December is determined, excess reserves will be accumulated starting from the second week of January, and interest will be paid on these funds. Yoon Kyungsoo, Director General of the International Department at the Bank of Korea, explained, "We will apply the US Federal Reserve's policy rate target range, but we are still considering the specific method, such as whether to calculate daily or use an average rate."
The expected effects are threefold: ▲ encouraging the inflow of financial institutions' foreign currency funds into the domestic market by offering higher interest rates compared to overseas investment; ▲ preventing the outflow of institutional and individual foreign currency funds by expanding short-term investment options for financial institutions; and ▲ improving supply and demand in preparation for the anticipated large-scale FX swaps by the National Pension Service.
On the 18th, the exchange rate between the Korean won and the US dollar was displayed on the status board in the dealing room at the Hana Bank headquarters in Jung-gu, Seoul. Photo by Yonhap News.
Banks: Higher interest income for risk, expansion of favorable foreign currency deposits, and 'domestic parking' of personal and corporate funds
Director General Yoon stated, "When financial institutions deposit funds that could otherwise be invested abroad with the Bank of Korea, it helps keep these funds within the country," adding, "For financial institutions, receiving interest at the Fed's policy rate target range (3.5-3.75%) is advantageous in terms of profitability." If these funds remain domestically, financial institutions can attract foreign currency deposits under better conditions. Director General Yoon noted, "Companies and individuals will also have more incentive to park funds domestically rather than sending them overseas."
An employee is holding up US dollars at the Counterfeit Response Center of KEB Hana Bank in Myeongdong, Jung-gu, Seoul. Photo by Yonhap News.
"Flexible FX hedging"-preparing for large-scale swaps by the National Pension Service
Another objective is to ensure ample liquidity in advance of large-scale FX swaps by the National Pension Service. Excess reserves accumulated by banks will be included in foreign exchange reserves and can be used as funds for swaps between the Bank of Korea and the National Pension Service. Director General Yoon commented, "It is true that some FX swaps between the National Pension Service and the Bank of Korea have recently resumed," and added, "With the extension of the FX swap agreement between the Bank of Korea and the National Pension Service, and as the National Pension Service implements its announced policy of 'flexible FX hedging,' there is a possibility that the volume of swaps will increase. This measure (interest on foreign currency reserves) will also be helpful in preparing for that."
He continued, "Even if excess reserves are deposited from mid-January next year, since the calculation of foreign exchange reserves is based on the end of the month, this will provide sufficient preparation. The National Pension Service determines the period for adjusting swap volumes, so we cannot know that in advance, but the Bank of Korea must respond according to the swap agreement, so we are preparing to ensure there are no operational issues."
The government will also temporarily exempt financial institutions from the foreign exchange soundness levy on non-deposit foreign currency liabilities for six months. The exemption period is tentatively set for January to June next year. This measure is expected to reduce borrowing costs by about 10 basis points compared to the cost of raising foreign currency liabilities overseas, thereby encouraging banks to increase the supply of foreign currency funds.
"Foreign exchange market stabilization measures-significant synergy expected from multiple actions"
Director General Yoon expressed expectations that this measure, together with the government's additional responses, will produce significant improvements in supply and demand through their combined effects. He explained, "The Bank of Korea and the government have introduced this measure as part of a series of actions, including the reform of the forward position system, easing burdens through the deferral of foreign currency liquidity stress test regulations, expanding the scope of foreign currency loans for residents for won-denominated purposes, and exploring a new framework related to the National Pension Service." He emphasized that, "Rather than the announcement of this single measure itself, it is the interconnection of various policies and the resulting improvements in supply and demand, along with changes in expectations, that will certainly have an impact."
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